Moscow fights back after sanctions; battle rages near Ukraine crash site

A woman walks out of a damaged multi-storey block of flats carrying her belongings following what locals say was recent shelling by Ukrainian forces in central Donetsk, July 29, 2014. (REUTERS/Sergei Karpukhin)

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Polina Devitt and Gabriela Baczynska, Reuters

Jul 30, 2014

, Last Updated: 11:34 AM ET

MOSCOW/KIEV – Russia fought back on Wednesday over new U.S. and EU sanctions imposed over Ukraine, where fighting between Moscow-backed rebels and government troops has intensified since a Malaysian airliner was shot down.

The worst confrontation between Moscow and the West entered a new phase this week since the United States and European Union took by far the strongest international steps yet against Moscow over its support for Ukraine's rebels.

New EU and U.S. sanctions unveiled on Tuesday restrict sales of arms and equipment for the oil industry, while Russian state banks are barred from raising money in Western capital markets.

Moscow called the sanctions "destructive and myopic" and said Europe and the United States would suffer. On Wednesday it banned imports of Polish fruit and vegetables and said it might expand the ban to the entire EU. Russian banks said they would seek financing in Asia. Novatek, a big Russian gas company that works with French firm Total, said it was studying the impact of sanctions on its international joint ventures.

On the ground in Ukraine, heavy fighting has been taking place near the site where Malaysian flight MH17 crashed into wheat and sunflower fields on July 17, shot down by what Washington and Brussels believe was a missile supplied by Russia.

Kiev accused the pro-Russian rebels on Wednesday of fortifying the area, including with land mines, to prevent the site from being properly investigated. The land mine report could not be independently confirmed. Ukraine is party to a treaty banning land mines; Russia is not.

The new Western sanctions mark the first time Washington and Brussels have adopted measures designed to hurt the overall Russian economy, after weeks of narrow steps targeting only specific individuals blamed for Russia's Ukraine policy.

"Russia's actions in Ukraine and the sanctions that we've already imposed have made a have made a weak Russian economy even weaker," U.S. President Barack Obama said in Washington on Tuesday. "If Russia continues on this current path, the costs on Russia will continue to grow."

German Economy Minister and Vice Chancellor Sigmar Gabriel said the measures would hurt the European economy but would hurt Russia more. The price was worth paying, he added: "At a time of war and peace, economic policy is not the main consideration."

The Russian Central Bank said it could support banks that were hit by sanctions. Russia's second-largest bank, VTB, said it would find funding outside of the EU and United States, using currencies other than euros and dollars.

But bankers said Russian firms had been effectively frozen out of global lending, and not just in the West, leaving the Russian state as their only source of funding.

"Right now, all banks are acting the same. No group is any more cautious or sanctions aware: It's all too important. Asian banks are the same as European or U.S. banks in this respect," a London-based banker at an Asian bank said.

A banker said VTB had been unable to find a lender for a $1.5-$2.0 billion refinancing loan since a previous round of U.S. sanctions on July 16. VTB declined to comment.

Russian stocks, which have fallen hard in recent days in anticipation of the new sanctions, recovered somewhat and were up around 2% on Wednesday.

The first European economic victims of the trade war were Polish apple growers, who sell more than half their exports to Russia. Moscow is by far the biggest importer of EU fruit and vegetables, buying more than 2 billion euros' worth a year.

Denying a link to the EU sanctions, Russia said it was banning most Polish fruit and vegetables for sanitary reasons and would look into expanding the ban to the rest of the EU.

The Polish agriculture ministry said the embargo "amounts to political repression in response to the sanctions imposed by the European Union against Russia", and said it would seek compensation from the EU.

FIGHTING

Moscow denies Western accusations that it has armed and supported rebels who are fighting Ukrainian forces in eastern Ukraine. But Western countries say flows of heavy weapons across the frontier have only increased since flight MH17 was shot down on July 17, killing all 298 people on board.

Ukrainian military spokesman Andriy Lysenko said the rebels were digging in for battle near the crash site: "They have brought a large number of heavy artillery there and mined approaches to this area. This makes impossible the work of international experts trying to start work to establish the reasons behind the Boeing 777 crash."

Despite what the West says is increased armaments for the rebels, government troops have advanced since the start of the month, when they pushed the rebels out of their best-defended stronghold, the town of Slaviansk. Since then, Western countries say thousands of Russian soldiers have returned to the border from which they had withdrawn weeks ago.

Valentyn Nalivaichenko, the head of Ukraine's SBU security service, said arms including Grad multiple rocket launchers were flooding across the border.

"Grads come in from Russian territory, take pre-agreed positions and fire on the Ukrainians. This is hundreds of rocket launches. They come in, shoot around like in a safari. This is serious military aggression," he told a news conference.

The rebels are mainly holed up in the cities of Donetsk and Luhansk, which they have declared capitals of two independent "people's republics", as well as in the surrounding countryside.

A team of Dutch investigators say fighting has prevented them from reaching the crash site. Most bodies of victims were shipped out in refrigerated train cars days after the crash and flown to the Netherlands, but some human remains are still believed to be lying untended in the fields.

The sanctions are intended to persuade President Vladimir Putin to back down from a months-long campaign to seize territory and disrupt his neighbor, an ex-Soviet state of 45 million where a pro-Russian president was toppled in February.

But Putin, whose popularity at home has surged with a strident nationalist campaign in state media since he annexed Ukraine's Crimea peninsula in March, has shown no sign of backing down from support for the rebellion in parts of Ukraine that he has referred to as "new Russia".

Before the Malaysian airliner was shot down, it seemed difficult to get EU countries to agree tighter sanctions: the European Union does 10 times as much trade with Russia as the United States does, and requires unanimity among its 28 members.

But the downing of the plane en route from Amsterdam to Kuala Lumpur changed the equation. Two thirds of the victims were Dutch, turning the Netherlands - the biggest importer of Russian oil bound for the rest of the EU - into a strong supporter of tough measures against Moscow.

The EU sanctions have nevertheless been crafted so as to inflict the minimum hardship on Europe: Russia's oil industry has been targeted but not the natural gas that fuels European industry and lights its cities. Existing contracts are excluded from the arms embargo, allowing France to move ahead with delivery of a warship it has already sold for the Russian navy.

Still, big Western companies, especially in the energy sector, will feel pain. Britain's BP, the largest foreign investor in Russia with a near 20% stake oil company Rosneft, said its business could be hurt.

French oil major Total, which owned 18% of Russian joint venture partner Novatek at the end of June, said on Wednesday it had halted buying Novatek shares the day of the plane crash. In April, Total had predicted the Novatek venture would make Russia its biggest source of oil and gas by 2020.

"We stopped buying shares in Novatek the day of the plane accident, considering all the uncertainties that this event could lead to," Total Chief Financial Officer Patrick de La Chevardiere said. Novatek, which was hit by U.S. sanctions the day before the Malaysian plane crashed, said it was examining the impact of sanctions on ventures with foreign partners.

Although Europe buys huge amounts of oil and gas from Russia, its exports to Russia are far more limited. Nevertheless it is vulnerable to pressure in particular sectors, such as German manufacturing and British financial and legal services.

According to European Commission figures, the EU sold 28% of its fruit exports and 21.5% of its vegetable exports to Russia in 2011, totalling more than 2 billion euros.

Tomasz Solis, deputy head of the Polish Fruitgrowers Association, told Reuters the trade war was no surprise: "The political situation in Ukraine would sooner or later have affected our relations with Russia."